Solution: Sell two rental condos, use net cash to pay down home mortgage, calibrate retirement income

A couple we’ll call Hank, 49, and Mira, 45, live in British Columbia. They have one child, who we’ll call Kelly, age 3. Monthly incomes and government benefits add up to $9,541 after tax, his from working in computer management for a large company, hers from local government. While they have several properties and some savings, they are not earning the return they should be on those assets.

“Are we at risk when we have so much of our money in property that pays nothing and might never?” Hank asks.

To help work out the relationship between their investments and their future, Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to examine the family’s accounts. “Their core issue is a couple of rental condos that are not good investments,” he explains.

Their earned income totals $15,300 per month. Taxes and deductions take about 38 per cent. Two rental condos generate $3,100 and $1,366 rent per month, but the first condo has costs of mortgage interest, condo fees, property tax and utilities that turn the income to a loss. This condo costs the couple $1,360 a year. The second condo’s costs add up to $1,224 per month, leaving a profit of $142 per month.

The return on equity — that is, net rent before income tax divided by the amount of equity they own — works out to minus 1.05 per cent on the first condo and a very low 0.83 per cent on the second.

Neither rental property is worth keeping, Moran advises. Further, their own townhouse mortgage is amortized over 25 years. In 11 years when they want to retire, it will still have 14 years of payments remaining.

The family’s budget shows salaries of $9,381 per month plus a $160 contribution from the Canada Child Benefit for total monthly income of $9,541.

First move: Make use of $41,500 cash on hand for RRSP contributions. Hank’s RRSP, which has $100,000 space, will produce a hefty tax break. Hank’s marginal tax rate is 38.3 per cent, so the refund could be as much as $15,895.

Second move: Sell both unprofitable rental properties. Condo #1 has an estimated value of $625,000 and a $368,000 cost. They could get $593,750 after five per cent selling costs. Its mortgage is $490,000. Allowing for five per cent selling expense and some primping, it might produce a $225,750 gain. The tax liability would be slight for Hank lived in it for seven of the nine years he owned it. He could walk away with perhaps $100,000, Moran estimates.

Condo #2 has a $500,000 estimated street price. Allowing for five per cent primping and selling costs, they would get $475,000, which they could use to repay the $300,000 mortgage, leaving them $175,000. After tax of about $45,000, that would give them about $130,000.

Cash liberated by selling the condos, plus $32,000 from their TFSAs, could be used to cut their $486,000 home mortgage to $224,000, Moran advises. Assuming that that the $2,336 monthly payments are maintained, this would cut the amortization of the home mortgage from the present 25 years to about 9 years, depending on interest rates. That would mean the mortgage would be gone by Hank’s age 58.

Educating Kelly

Kelly’s RESP has a balance of $11,700. At age 17, assuming the parents contribute $2,500 per year plus the $500 Canada Education Savings Grant to a maximum of $7,200 per beneficiary, total $3,000 per year for another 11 years, then $2,500 for three years, and obtain a three per cent return over inflation, the account will have $67,400, enough for four years’ tuition at a post-secondary B.C. institution.

Retirement finances

If the couple retires in 16 years when Hank is 65, they will have two pensions, one a defined benefit plan, one a defined contribution plan, a company share purchase plan, two RRSPs and two CPP and OAS benefits.

Mira will be eligible for two per cent of the average of her last five years’ pay times years of service. She earns $7,000 per month, $84,000 per year. With a late start in her work, her pension would be about $30,000 per year.

Hank has a defined contribution pension. He adds $57.50 per month from payroll and the company puts in $345, total $402.50 per month. His $103,000 balance will grow at 3 per cent after inflation to $262,650 at his age 65. Paid out for 30 years to exhaust all capital and income, it would generate $13,500 per year.

Hank’s RRSP has a $180,000 present value. He adds $76 per month. In 16 years, assuming 3 per cent growth after inflation, the RRSP will hold $307,200. If paid out over 30 years to his age 95, it would generate $15,600 per year.

Mira has $85,000 in her RRSP from past contributions and growth. The Pension Adjustment severely limits her contribution room each year so she adds nothing of her own. If the present balance grows at 3 per cent after inflation for 16 years, it will become $136,400 and support annual payouts of $6,756 for 30 years.

Hank also has a company share purchase program. He adds $504 per two week pay period from payroll. The plan, from which he takes no cash, has $7,000 at present. If continued for 16 years to his age 65 with 3 per cent growth after inflation, it would become $275,400 and then support payouts of $14,050 for the next 30 years. At age 65, each partner would receive $7,217 from Old Age Security and, at the same age, based on contributions, Hank would get $13,610 per year from CPP, Mira $11,570 from CPP accounts.

Adding up the various sources that would be available at age 65 gives a pre-tax total of $119,520. If eligible pension income is split, each partner would have $59,760. After 16 per cent average tax, they would have $8,370 per month to spend.

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